Growing Leaders. Transforming Businesses.

Financial focus
AN E CO NOMIC U PD AT E B Y ROG ER M AR T IN-F AG G
Invest in What you Believe In Any business with a clearly defined value proposition based on the customers preferences and ability to pay, which is effectively and efficiently delivered will outperform the economy as a whole, and by a considerable margin.
This article has been edited from Rogers Economic Update for February 2013 for this publication with his support.

Irrational Exhuberance
Animal spirits are running hot. Financial markets create their own reality. Companies are refinancing at lower interest rates, Eurozone Governments find it easier to finance their deficits, the US fiscal cliff is delayed until May, and China has avoided a hard landing. Greece is still in the Eurozone, Spain has not asked for a bailout, the ECB has not had to purchase outright a single sovereign bond, and money is flowing from safe havens back to the Eurozone periphery. The US housing market has turned, posting 5% price increases, new housing starts are twice the 2009 low. S&P 500 companies earnings are flat, sales up 0.5%, and People are irrational. We make generalisations about the whole based on the performance of one part, the so called halo effect. yet the index is up at its pre-slump level. The Footsie is up 6.4% since Jan 1, and Japans Nikkei is up 7% The US economy shrank in Q4 2013, Europe is shrinking, 55% of Chinese GDP is now state financed spending and a major realignment of global currencies is in prospect. See next section.

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Irrational Exhuberance
And we are prey to our emotions when making decisions, these are easier to manipulate than we think. We all think we are above average, and our subjective confidence in our abilities and judgments usually outweighs the actual strength of either of them. And above all we are herd animals; we make decisions based on what those around us are doing. We often justify our choices like this, validating them on the basis that others were following a similar course of action. It is tempting to view the surge in stock prices as a result of inflationary expectations driving an exodus from bonds, but the evidence from the USA is that it is new money flowing into equity mutual funds. So look at the data: the purchasing managers index show contraction in the Eurozone, no growth in China (this means 7%), but expansion in the USA. People always prefer to carry on behaving as they have always done, the more we repeat particular behaviours, the more automatic they become, and over time they become default behaviour. So the reasoning must be this. The USA is growing, interest rates will remain at current levels for years to come, the Euro is fixed, and China always creates its own reality. Therefore time to get out of cash into equities. Our reflexive system does not naturally check to see if rephrasing a question would produce a different answer. For example the market analysts say that equities are cheap based on long run P/E multiples, but what we are The Zombie businesses will go sooner or later, leaving more market for the better players. I have said this many times before but it is worth repeating. Any business with a clearly defined value proposition based on the customers preferences and ability to pay, which is effectively and efficiently delivered will outperform the economy as a whole, and by a considerable margin. We can take the example of John Lewis (outperformer) and compare it to Dixons. Victoria Campbell, Managing Director Rotary Watches The markets have ignored the second bailout of Italys second largest bank, and the bailout of the Netherlands third largest bank last week. They are ignoring the fact that nominal GDP in the UK is only growing at 2.5% and net credit is still contracting at 4%. The UK Government will not hit its debt reduction target and according to the IFS will need to borrow 180Bn more than planned over the next three years. This will push the National Debt over 80% of GDP and close to France who have 86%. But the talk on the street is that confidence is returning, we are on a roll, Spring is in the air! The cash piles will be spent, the velocity of money will take off and we will reach the sunlit uplands. This could happen but............... experiencing today is a discontinuity, thus trend is almost irrelevant.

I joined the Academy so that I could get the input of a mentor for my business and me. I have found the external input from both my group chairman mentor and the professional expert speakers really invaluable in developing the strategy for my business. I would recommend the Academy for anyone who is serious about pushing their business to the next level.

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Exchange Rate
For the past 3 weeks there has been a lot of market chatter about the realignment of the major currencies. As the market creates its own reality, we can expect the realignment to take place. We do not know exactly when or by how much. Here is the context. We begin with Purchasing Power Parity (PPP). If two identical goods have the same price in two countries, each with a different currency, then there is PPP. If you are in country B, and you exchange your currency for As, and you find that the identical good is now cheaper for However in the short run it is financial variables plus market expectations which determine the relative exchange rate.
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you in A, then using PPP, your currency is overvalued relative to A. Over the long run (more than 5 years) currencies do move towards their PPP unless deliberately managed by the Government through direct sales and purchases in the Forex market using the central bank. China has deliberately done this for 20 years.

Graham Nye, Managing Director Chiltern IT

Each point on this triangle is determined by the other two. So what determines the relative exchange rate? It is relative interest rates and relative inflation rates. Based on these relativities for January 27 2013 the following PPP apply.

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Exchange Rate
All this is relative to the US Dollar. OVERVALUED Norwegian Krone 90% Swiss Franc Aussie Dollar Swedish Krona Kiwi Dollar Canadian Dollar Yen Euro Sterling 78% 64% 47% 44% 24% 14% 13% 6% Russian Ruble 21% Brazilian Real 7% If we take Sterling it implies that $1.47 is the equilibrium price in dollars and Euro 1.08. Now we need to see what will feed market expectations. First the UK balance of payments as shown on the chart on the next page. For most of the last 13 years our physical trade deficit has been partially offset by investment income from our ownership of assets abroad. The remaining deficit has been financed by the sale of UK assets to overseas buyers e.g. Tata, Mittal, Sovereign Wealth Funds, and my village pub now owned by a Russian (a disaster!) We are in a spot of bother because as you can see, the investment income flow has reversed. And the short term balancing from the Greek and Spanish has gone as they decide
4

UNDERVALUED Rupee Yuan 63% 32%

Mexican Peso 30%

Turkish Lira

25%

the Euro will survive. Normally an increase in UK interest rates would solve this. But such an increase (of 2%) would kill us. So the markets now are assuming that Sterling has to fall to enable us to balance the account. A weak currency encourages speculative inflows once the market thinks the bottom has been reached. The problem is the market always overshoots; this creates bigger swings, and more bonuses for Forex teams who call it right. As I write this on February 7, Sterling is Euro 1.15 and $ 1.56. The swing has already begun. But there is much which can stop the downward movement.

Since joining the Academy my leadership skills have changed quite significantly, and I think thats to do with the fact that I recognise and understand what kind of leader I really am, rather than what I thought I was.

Liz Smith, Managing Director Savvy Social

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Exchange Rate
For example Bunga Bunga Berlusconi could win the Italian Election and play hard ball with Merkel by threatening the breakup of the Euro. When the interest rate and inflation rate differentials are small non-financial events become more significant. The French have suggested that the Euro should be allowed to fall against the dollar (achieved by a lowering of the ECB rate of interest to 0.5% and more QE). The Germans think not. The new Governor of the Bank of England is suggesting a radical rethink of the role of the monetary policy committee, but is sketchy on detail.

Membership of the Academy has helped me enormously. The company now has a very solid strategic direction backed up by a much stronger management team, which is taking us in to new markets and creating higher levels of both profitability and service.

Nick Appell, Managing Director Casna Ltd

On balance Sterling is close to equilibrium, but we should expect more volatility than usual, as downward movements quickly reverse. On the next page is a chart which illustrates this for the past year. There has been a swing of 10% for Pound/ Euro from July last year to Feb 3 this year.

This gives the context for those of you for whom currency values are crucial determinants of your margin. I cannot tell you what the actual rate will be on April 28th. You will have to make an informed guess like the rest of us.

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Exchange Rate

And now to my School Report for the year 2012

In the three years since joining the Academy in 2009 we have achieved 168% growth; the Academy has played a major part in achieving this.

Forecasts for 2012 (and the actuals)

Please note that numbers in parentheses have a negative value House Prices outside London: nominal (2%) real (5%) ACTUAL (2.1%) (5%) Commercial Property: flat ACTUAL flat GDP for the year 0.3%, Q1 and Q2 slight contraction, Q3, Q4 some slight growth. ACTUAL Q1 (0.2) Q2 (0.4) Q3 0.9 Q4 (0.3) 0.0% for the year

Alistair Kight, Managing Director GRITIT

The UK
UK inflation: RPI 3.2%, CPI 3.5% ACTUAL RPI 3.1% CPI 2.7% UK interest rates: 0.5% ACTUAL 0.5% FOOTSIE 100 at year end 5,500 ACTUAL 5800

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

Forecasts for 2012 (and the actuals)

Oil: the Saudis Sectors: Manufacturing will grow more slowly than the last two years: European demand will be patchy with some shocks. Asian and US demand stronger. Non-food retail will continue to be very difficult with more failures. Financial services flat. Government sector: cuts will begin to bite. CORRECT Construction: 1% real growth ACTUAL (11%) Unemployment: 2.8 million at year end ACTUAL 2.6 Private sector wage growth 2%, public sector 0% ACTUAL 1.6% and 0% need $100 pb to break-even on the increased bribes to their population. They will cut output to maintain this price in 2012 and 2013. CORRECT Non-food commodities, prices will fall. CORRECT Food commodities, harvest dependent, but steady upwards price pressure from Asian demand. CORRECT These forecasts assume Europe stumbles on. If the Greek default (likely April 2012) creates a Lehman-like effect, then all bets are off. It will be a repeat of 2008-2010. GREECE MANAGED DEFAULT SEPT

ABOUT THE AUTHOR

Roger Martin-Fagg, BA Hons

Roger is an Associate of Ashridge Business School, teaching all aspects of economics on Executive and Corporate programmes. He works with a diverse range of clients, including the financial services, construction and travel industries, to design, manage and teach strategic management programmes. He also works with the owners of SME's helping them to read and interpret the trading environment.

The World Headmasters comments

Global growth will be 2.5%, USA 2%, Brazil 2%, India 7.5%, China 7% Europe (1.5%) Russia 3% ACTUALS all correct except Europe which grew by 1% This has been a surprisingly good year for Martin-Fagg, but we sometimes think his disarming smile indicates a brain working at half power. (This is a direct quote from my 1964 school report!)

The Forecast for 2013

Footsie 5900 at year end UK UK CPI 2.8% GDP 0.3% RPI 3% Russia 3% The World GDP 2.9% Exchange rates 1 = Euro 1.23 average but big swings, I still think the Euro is at risk and sentiment will turn against it during this year. 1 = $ 1.55 average until late summer, then could go to 1.45 by year end.

Current and recent clients include Taylor Wimpey, BAA, Experian, Lloyds-TSB, Barclays, Hanson, Cairn Energy, Nandos, Specsavers, and Allied, Milling and Baking. Prior to a career in teaching and consulting, Roger worked in the New Zealand Treasury and the Air Transport Training Board as an economist. His extensive knowledge of manufacturing, distribution, financial services and energy sectors and skill in the presentation of complex economic issues have earned him a reputation as a teacher, consultant, writer and broadcaster over the years. He was one of the few who predicted the financial crisis. As a behavioural economist he focuses on behaviour and feedback loops which are largely absent from conventional models.

Eurozone (1.5%) USA 2.3% Brazil 1% China 7.6%

tin-F ger Mar Ro

agg

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author

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